Earnings season is in full swing, and as per usual, the big banks were up first.

The numbers so far have been ugly.

Compared with results from the second quarter of 2019, the results for the second quarter of this year range from bad to really bad.

Here’s a sampling…

  • JPMorgan Chase (NYSE: JPM) reported that second quarter earnings were down 52% from $2.82 per share in 2019 to just $1.38 per share this year.
  • Bank of America (NYSE: BAC) saw second quarter earnings cut in half from $0.74 per share last year to $0.37 per share this time around.
  • Citigroup (NYSE: C) saw earnings fall even more, dropping 75% from $1.95 per share last year to $0.50 per share in 2020.
  • Wells Fargo (NYSE: WFC), which has the least trading revenue, posted a second quarter loss of $0.66 per share compared with a $1.30 per share profit in 2019.

By a wide margin, banks just had their worst quarter since the financial crisis…

And yet, now is an extraordinarily good time to buy shares of American banks.

Let me explain…

Near-Term Earnings Will Be Bad, but Balance Sheets Are Sound

I’m not bullish on the banking sector because I think earnings will skyrocket next quarter.

In fact, I expect the next several quarters to be challenging.

The economy is suffering. Lots of people are out of work, and nonperforming loans are certain to rise. This is par for the course in a recession.

But the banking sector is in an incredibly strong capital position. Balance sheets are ready and able to absorb credit losses – so this is not 2008 or 2009 all over again.

I’m confident for two key reasons…

  1. Banks’ balance sheets are much less leveraged than they were going into the financial crisis.Ten years ago, bank balance sheets were leveraged 30-to-1. For every $1 of shareholder capital the banks had, they had a whopping $29 in debt. Today, the sector has a leverage closer to 10-to-1. The industry is very conservatively capitalized because bankers, regulators and borrowers don’t want a repeat of 2008 and 2009.
  2. We don’t have a giant housing bubble this time around. This matters because properties that a bank holds as collateral won’t plummet in value.During the financial crisis, the value of banks’ real estate collateral collapsed. That meant that repossessed properties were not worth enough to recover the amounts owed on loans.

Today, even in the event of default, the banks’ collateral will cover what is owed on the properties.

Long-Term Earnings Power Is Intact

Banks’ bad second quarter earnings numbers reflect provisioning for future expected credit losses.

Once the need to build up those credit provisions ends, the sector will quickly return to the same level of earnings that it had in 2019.

So yes, near-term earnings will be weak – but intermediate-term earnings won’t take a hit.

Meanwhile, share prices in the banking sector reflect near-term challenges, not the eventual intermediate-term rebound. The American banking sector, as represented by the SPDR S&P Bank ETF (NYSE: KBE), is still down almost 35% year to date.

Some individual banks are down even more…

These stocks are near or below the lows hit in 2009 on every valuation metric that captures their intermediate- and long-term earnings power.

In other words, these stocks are priced like the global financial crisis is happening again.

But it isn’t. Balance sheets are in exponentially better shape today, and the banking sector represents the best value in the market.

This trade requires patience, but for investors who can wait, it will pay off very well over the next couple of years.

Good investing,

— Jody

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Source: Wealthy Retirement